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Promoters of India Inc, who have been earning tax-free dividend income by holding shares in companies through private or family trusts, will take a 10 per cent hit on their dividend income after Union Budget 2017. This new law will also be applicable to trusts that operate and manage employee stock ownership plans (ESOPs).
An additional tax of 10 per cent will be applicable on dividend income over Rs 10 lakh a year.
“According to the proposed norms, family trusts and ESOP trusts will need to pay tax. Only domestic companies, charitable trusts, religious trusts, hospitals and education institutions won’t need to pay this tax on dividend,” said Amit Maheshwari, partner, Ashok Maheshwary & Associates.
This new tax will lead to higher tax incidence on trusts of India Inc’s top promoters including Azim Premji, Mukesh Ambani and Harsh Mariwala.
Family trusts owning shares of companies of the top 100 companies (from the BSE 100 index) earned dividend income of Rs1,600 crore in FY16. Assuming the same dividend in FY18, these family-owned trusts would have to cough up Rs160 crore as additional dividend tax. The combined dividend outgo by BSE 500 companies has grown at a compounded annual growth rate (CAGR) of 9.2 per cent during the first two years of the Narendra Modi government.
Among individual promoters, the biggest hit will be taken by Pankaj Patel's Zydus Family Trust, which owns 74.8 per cent stake in Cadila Healthcare, India’s sixth largest pharma company by revenues. Last financial year, the family trust is estimated to have earned dividend income of around Rs245 crore from Cadila Healthcare. Under the new tax rules, the trust would now have to shell out an additional dividend tax of Rs24.5 crore in FY18 assuming the dividend is the same as in FY16. The actual tax burden could be higher as Cadila’s dividend payment is growing at a compounded annual growth rate or CAGR of 33 per cent having doubled in the last three years.
Azim Premji Trust, which owns 16.4 per cent stake in Wipro would pay a dividend tax of around Rs24 crore, based on Wipro’s numbers for FY16. Other top trusts of promoters such as Reliance Industries’ Mukesh Ambani’ and Eicher Motors’ Siddhartha Lal will also be affected.
The new tax rules will also hit public sector energy major Bharat Petroleum Corporation, which has a trust for holding some of its shares and Tech Mahindra’s employee trust. (See chart)
After considering 30 per cent corporate tax, 20.4 dividend distribution tax (including surcharge) and the 10 per cent tax on dividend income in excess of Rs10 lakh, the effective tax rate for promoters owning shares either in person, through Hindu Undivided Family or private trusts would work out to over 36 per cent. The calculation is based on the assumption that a company distributes 30 per cent of its profit after tax as equity dividend.
Private trusts to take dividend hit
However, it depends whether the trusts established for ESOPs is a definitive trust or not. “If the trusts define the ownership of share, the tax will be in the hands of the owner. If the ownership of shares is not defined, then the trust would need to pay the tax,” said Amarpal Chadha, tax partner, at consultancy, EY.
Tax experts say that the government brought this move to pre-empt promoters who could have used the loophole to shift their holdings to family trusts to evade dividend tax first introduced in the last Budget. “Prior to Budget 2017, we agreed that a potential structure that could be explored to mitigate the levy of the dividend tax would be to settle the shares into a trust. The Budget closes this option now,” adds EY Amarpal Chadha.
Besides hitting promoters’ finances, the new tax measure also has implications for the management of family wealth of promoters' families. “Many business owners moved their shareholding to family trusts. The trust structure is more suitable as it helps in estate planning, succession planning, managing wealth jointly and had been tax efficient,” said Jiger Saiya, partner — direct tax, BDO India. But now it will have an adverse impact on family trusts.
A trust still remains a more viable option for promoters than a holding company. “There’s benefit of capital gains tax. If the shares are held in a company, there is minimum alternate tax (MAT). In a trust, there’s no MAT. Also, there are expectations that the government would introduce tax on inheritance in the future. A trust would be the most tax efficient way to bequeath assets,” said
Rahul Garg, leader, direct tax, PwC India.
Trusts are also preferred as the beneficiaries and managers (trustee) are different. This ensures that the head of the family can have wealth distribution and management the way he wishes, even after he passes away. “Another popular structure is limited liability partnership (LLP) for holding company structures,” said Maheshwari. According to him, many corporates are using LLPs as holding companies because they save on the dividend distribution tax. “However, opening an LLP as a holding company requires many permissions, including from the Reserve Bank of India,” said Maheshwari.
9.2 per cent: The combined dividend outgo by BSE 500 companies at a compounded annual growth rate during the first two years of the Narendra Modi government.
Among individual promoters, the biggest hit will be taken by Pankaj Patel’s Zydus Family Trust, which owns 74.8 per cent stake in Cadila Healthcare, India’s sixth largest pharma company by revenues.
Rs 24 crore: Dividend tax to be paid by Azim Premji Trust, which owns 16.4 per cent stake in Wipro, based on Wipro’s numbers for FY16.
After considering 30 per cent corporate tax, 20.4 dividend distribution tax (including surcharge) and the 10 per cent tax on dividend income in excess of Rs10 lakh, the effective tax rate for promoters owning shares either in person, through Hindu Undivided Family or private trusts would work out to over 36 per cent
